Please stand by. We're about to begin. Good morning, and welcome, ladies and gentlemen, to the RLI Corp. second quarter earnings teleconference. At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. At the request of the company, we will open up the conference for questions and answers after the presentation. Before we get started, let me remind everyone that through the course of this teleconference, RLI management may make comments that reflect their intentions, beliefs, and expectations for the future. As always, these forward-looking statements are subject to certain risk factors which could cause actual results to differ materially. These risk factors are listed in the company's various SEC filings, including in the annual Form 10-K, which should be reviewed carefully.
The company has filed a Form 8-K with the Securities and Exchange Commission that contains the press release announcing the second quarter results. RLI management may make reference during the conference to operating earnings and earnings per share from operations, which are non-GAAP measures of financial results. RLI's operating earnings and earnings per share from operations consist of net earnings after the elimination of after-tax realized investment gains or losses. RLI's management believes this measure is useful in gauging core operating performance across reporting periods but may not be comparable to other companies' definitions of operating earnings. The Form 8-K contains reconciliation between operating earnings and net earnings. The Form 8-K and press release are available on the company's website at www.rlicorp.com. I will now turn the conference over to RLI's Vice President of Corporate Development, Mr. Aaron Diefenthaler. Please go ahead, sir.
Thank you. Good morning to everyone. Welcome to the RLI earnings call for the second quarter of 2016. Joining me on today's call are Jonathan Michael, Chairman and Chief Executive Officer, Craig Kliethermes, President and Chief Operating Officer, and Todd Bryant, Vice President and Chief Financial Officer. I'm going to turn the call over to Todd first to give some brief opening comments on the quarter's financial results. Craig will talk about operations and market conditions. We'll open the call to questions, and John will finish up with some closing comments. Todd?
Thanks, Aaron. Good morning, everyone. The second quarter was another good one for RLI. Our primary focus remains to outperform the industry in underwriting profit and an 85 combined ratio for the quarter is a testament to our continued success in that regard. As with previous quarters, underwriting income was positively impacted from net favorable loss reserve development. In this case, $15 million spread across all three segments. The casualty segment led the way with $11 million of favorable development, followed by property and surety segments of $2 million each, respectively. Slightly offsetting this benefit was $3 million of storm losses, a relatively benign level compared to prior years, with $6 million in 2015 by comparison. Despite the inherent potential for quarter-to-quarter variability in both reserve releases and storm losses, RLI's business model continues to benefit from our highly diverse product portfolio.
This applies to growth as well as profit. In the quarter, both the casualty and surety segments demonstrated strength. Casualty gross written premiums grew by 7% while posting a 90 combined ratio, while surety grew 4% and posted an outstanding 75 combined ratio. The property segment's top line remains challenged, particularly for cat-exposed products, and this is reflected in the 14% decline in premium. Although absent the final drag from our exit from crop reinsurance, the decline was modestly better at 5%. Despite these challenges, property posted an excellent 81 combined ratio. In total, gross written premium grew 1% or 3% excluding crop. The investment portfolio continued to post strong returns with a 2.8% total return for the quarter and a 6.1% gain through six months. Declining interest rates and positive equity market conditions continue to drive positive performance.
With regard to our minority investment in Maui Jim, it turned in slightly lower income. Although sales continued to grow modestly, foreign exchange impacts continued to dampen earnings. One item to note is the non-cash goodwill impairment related to our medical professional liability business. Due to continuing pricing pressures leading to declining premium volume, coupled with some adverse loss experience reported during the second quarter, we reevaluated the fair value of this business and concluded the carrying value of this goodwill was in excess of fair value by $7.2 million. Nonetheless, the business remains profitable, albeit at a lower premium level and higher combined ratio, and we remain committed to this business.
All in all, with strong underwriting and investment performance driving our results, operating income came in at $0.61 per share, and book value per share is now up 12% in the first half of the year, inclusive of dividends. With that, I'll turn the call over to Craig Kliethermes for further commentary. Craig?
Thanks, Todd. Good morning, everyone. We recorded another solid quarter given market conditions. Gross written premium was up a moderate 1% for the quarter. Removing the impact of crop and the facultative reinsurance business we exited last year, our premium was up 4% on a gross basis and more than 5% on a net basis. Our core portfolio is on a good trajectory in a challenging market. At the same time, we were able to deliver another sub 90 combined ratio. We have made several investments in people, products, and technology that are starting to gain traction. In addition, we have about one-third of our product portfolio that is related to the construction industry, which continues to rebound and provide more opportunity to us. Let me provide some more detail by segment.
In casualty, gross written premium was up 7% in the quarter, which is similar to our year-to-date growth rate in this segment. We produced a 90 combined ratio. We continue to find opportunities both in our established products and within many that we have started in the last several years. Our transportation and P&C package businesses continue to grow at a double-digit pace for the quarter. Our transportation business has opportunities resulting from carriers that were undisciplined in their pricing over the last several years. Many established markets appear to have endured enough pain for now that they're taking a timeout to reassess, or they're now charging enough so that we are more attracted to the risk. Much of our package growth has come the old-fashioned way, pounding the pavement and visiting our producers and finding new ones that value our specialty products, service, and narrow and deep expertise.
We continue to invest in new people and new products across our casualty segment. We are working hard to get more products online and to scale. Many of these gained some momentum this quarter. We are hopeful what the future might bring. Casualty rates are relatively flat overall, but we continue to see positive rate on most wheels-based business and in the smaller account, non-medical professional liability space. However, we are having to give back some rate in primary general liability, medical professional liability, and on larger D&O risks to remain competitive. We are fortunate to have specialty underwriters who understand that to outperform through all market cycles, selection is king. Our property segment was down 14% while reporting an 81 combined ratio. More than half of the decline is due to the previously mentioned exits of crop and facultative re.
The cat business remains a very tough story. Prices continue to decline at a double-digit pace. We've been able to offset a portion of the decline with reduced reinsurance rates. We have found some opportunity by diversifying our exposures. This has helped us take some of the pressure off our returns and the bottom line. On a more positive note within this segment, our marine and Hawaii homeowners businesses grew profitably by staying focused on and targeting producers in classes where they have seen the most success. Our surety segment continues to grow profitably. We are up 4% for the quarter and 5% year to date, while posting a 75 combined ratio. Our long-term presence, relationships, and consistent predictable risk appetite are a big advantage for us in this segment. Surety was led by our miscellaneous product, which continues to grow at a double-digit pace.
These are typically very small bonds where ease of doing business is a critical differentiator. We continue to invest in technology to stay top of mind with our producers and differentiate ourselves. On the larger surety risk, it remains very competitive. Although results have been good for the industry so far, we have seen a lot of undisciplined players. New business is very difficult. Prices continue to go lower with credit terms that seem careless. Our surety team has weathered the storm before. They continue to build on their deep relationships in their respective niches to find opportunities to grow profitably. Overall, we had a very solid quarter. I'm very proud of our underwriters, claims professionals, and associates who continue to perform like the owners they are, by demanding excellence from themselves and each other. Thank you.
I'll turn it back to Aaron, who will open up for questions, I believe.
Yes. Operator, we can now open the call for questions.
Thank you, sir. The question and answer session will begin at this time. If you're using a speakerphone, please pick up the handset before pressing any numbers. Should you have a question, please press star one on your telephone. If you wish to withdraw your question, please press star two. Your question will be taken in the order that it is received. Please stand by for your first question. Our first question comes from Randy Binner.
Hey, good morning. Thank you. I just want to ask a couple, actually, on property. It seemed like the underlying loss ratio was actually pretty good there. Axing out the cat impact, was there anything unusual from an underlying loss perspective in the quarter that helped that good result?
Randy Binner, this is Craig Kliethermes. I would say, we've been working on marine for a while, and those results have been getting better. Obviously, our cat business continues to perform. We haven't had the big cat losses I know some others have had. We've been working on, I think we've talked about our RV business in the past. Hopefully, the results seem to be getting better there. I don't know, other than maybe mix and some small improvements in spaces where we needed some help. That's really the only thing I could help explain.
That's helpful. Then on, I think last call or last couple of calls, the commentary around property rates relative to loss cost trends has been pretty negative, and obviously you're continuing to shrink the top line there. Is that still a good generalization? I know you have niche businesses in marine and RV, as you just mentioned. Are property rates in general kind of moving below loss costs in the market, and should we kind of expect you to continue to pull back to this degree?
Randy Binner, again, Craig Kliethermes. Obviously, it's a very diverse property portfolio. Certainly, that is probably true from a cat perspective. I don't think we believe the underlying loss costs are getting better. The rates are certainly going down. Certainly there's some deterioration, but it's hard to observe a lot of deterioration if you don't have big losses, right? Because the loss ratio is zero if you don't have any losses. Certainly that underlying mix is changing. For RVs, I think they're experiencing the same underlying auto trends, because that's mostly a physical damage coverage. They also are exposed to those underlying auto trends, which I think you've seen in the rest of the market, and I think we've felt it a little bit in that space as well. Marine continues to get rates we think equivalent to loss cost They are getting some small rate increases.
Our Hawaii homeowners business is an admitted product, so we haven't seen, again, that's mostly a cat business, but so I haven't seen a lot of cats in Hawaii recently.
RV, you mean the frequency, you're observing frequency trend that, it's summer, we know folks are driving the RVs more. Do you mean the kind of distracted driving and higher accident frequency outside of normal seasonality, you're observing that in the RV book?
Well, it certainly stepped up a couple of years ago, and I think it remains at that level. I don't see it continuing at its same growth rate necessarily or continuing to accelerate the trend, the trend certainly jumped up a little bit several years ago, and we have yet to see it subside. We are getting fairly sizable rate increases in that space. That's also an admitted space, we have to file and get approvals, we have filed fairly significant rate increases over the last couple of years, and that book has shrunk fairly significantly. We had double-digit rates over the last couple of years because of that.
Got it. I'm just going to ask one on MedMal, and I'll drop back in. With this Rockbridge deal, I guess, with the benefit of hindsight now and this adjustment on the goodwill, what changed the most since from when you did the deal in 2012? I guess, what was the trend in that business or the issue that's caused some adverse development?
Yeah, Randy, it's Todd Bryant. I think you used a good word now in hindsight, because that's basically kind of the look you have to take on this. When we bought it back in, I want to say, late 2012, the rates were pretty sound. They were producing north of $16 million, almost somewhere between $16 million-$20 million in premium on an annual basis prior to that. I think unfortunately, subsequent to that time, we've seen a year-over-year decline in rates. I think true to the core RLI underwriting discipline, we shrunk that book. That's one, again, it's because you have to go back to the reason we were attracted to them in the first place is they had RLI-like underwriting discipline. That has shrunk. It's down to about just north of $10 million today.
I think as you read our prior SEC filings, 10-Qs, 10-Ks, we've been signaling that the top line has been declining. What happened in this quarter is you had a few adverse developments or claims that had come in the door. You couple that with a combined ratio went up a bit, several percentage points. When you go to the accounting convention, that triggers impairment that you go through, and fair value as a consequence was below the carry value of the goodwill. Does that address your question?
What was the nature of the higher, the elevated claims?
It's a small book, probably somewhere in the neighborhood of about 200 policies. You get a couple, you have two particular policies that had some kind of rather large losses. When you have such a low base of premium, that can be a very significant impact to the combined or the loss ratio piece of the combined ratio. Unfortunately, you have to kind of use your kind of contemporaneous assumptions in looking forward into perpetuity under the accounting model is your determination of the fair value. I think as we all know, this is an industry that works in cycles, we do have confidence that it'll recover in time. That's why we remain confident and like the business, but the accounting model doesn't allow you to anticipate that.
Okay. Understood. I guess the good news is there, to the extent you shrunk the book, that may have cut off the tail of even greater losses. Is that the positive way of looking at it?
Well, Randy, I think Todd mentioned it, that is kind of our modus operandi is if the market is not going to bear the rate we need, we tend to shrink. We certainly shrunk this book, and we were hoping that the loss ratio would maintain the same level. It's elevated a little bit. The combination of that elevated loss ratio and the reduced premium, unfortunately, in the accounting world says it's worth less money or worth less money on our books anyway. We still have a lot of confidence that our underwriters can address the underlying deterioration, and we're hoping that market starts to stabilize. As of right now, I think I mentioned that earlier, that's one of the areas where the rates are still declining the most. It's a challenge.
Understood. Thanks a lot.
I think we're competing with companies that have been in it for a while, and they have a pretty big reserve margin built up, and they may not be seeing what the current accident year loss ratio is, or certainly maybe that message is not getting to their underwriters. Still producing good calendar year results for the most of the industry.
Got it. Thank you.
Our next question comes from Arash Soleimani.
Thanks. I'm just curious also on the MedMal front. Does Berkshire getting bigger in MedMal through Medical Liability Mutual Insurance, does that, you think, impact you guys competitively in any way?
This is Craig again, Arash. I think that company is an admitted company. We compete in the E&S space, which is really more with the Evanstons, Essex of the world. We probably won't go head to head, I say that in most cases. However, we have seen the admitted folks reaching out into the E&S space and starting to write doctors and physician groups that wouldn't normally be within their strike zone, which would be left for the E&S market. Unfortunately, I can't say for sure, but we don't typically compete with them head-to-head.
Okay. That's fair. Kind of just what you were saying before on that front, you still expect rates to be pretty soft for the foreseeable future in that line. Just basically the reason being that a lot of the peers that you're competing against have large positive reserves that they can use to buffer their way through with lower rates. Is that kind of the takeaway?
Well, I assume you look at industry studies like I have, the industry studies have said the medical malpractice line is the most over-reserved line remaining. They would probably have some area to compete, some room to compete in the short term.
Okay. That's fair. Then you had mentioned getting some products to scale. Should we expect that to start to benefit the expense ratio going forward?
Well, certainly we've invested in some cases it's been teams of people, in some cases, it's been taking existing underwriters and focusing on new things. Obviously, as they scale up and gain some margin or some revenue, it's obviously going to help the denominator of that equation gets larger. We hope that a lot of those expenses are somewhat fixed. There's some variable ones, obviously, in commission and tax. That should hopefully help that and help the top line, which should help the expense ratio.
That's fair. Then lastly, I know you probably can't give too much color on this, in terms of the prior period development, should we expect it going forward to kind of be more in line with what we've seen sort of year to date? Is that not the right way to think about it?
Yeah, Arash. John Michael here. Yeah, we can't forecast any kind of reserve development into the future either way. It is what it is. I think you know that.
Right. That makes sense. Okay. Thank you very much for the answers.
Thank you.
Okay. Our next question will come from Jeff Schmitt.
Hi. Good morning, everyone.
Good morning, Jeff.
On the investing side, other comprehensive income was pretty sizable at $19 million. What drove that?
Jeff, it's Todd Bryant. Touched on that a little bit in my comments. With some of the interest rate declines, again, on the accounting model, mark-to-market indications on the fixed income portfolio, those would increase rather significantly up. Let's see if I have it here. Year to date, about $47 million. I'm not sure I have it broken down by the quarter. Likewise, the equity's had a good run as well. That also finds its way into the comprehensive income on the unrealized basis, offset by whatever we would've harvested on the realized side. Yeah, had a very favorable impact for the quarter and a half.
What percentage of the bonds are available for sale versus held to maturity?
Yeah. It's 100%.
They were still mark to market. None of it's held to maturity?
Several years ago, I think we sold the last bond that was going to be held to maturity. Yeah, it actually matured. Yeah, it's 100% in the held for sale category today. All mark to market.
Okay. On the E&S side, I know you had mentioned on the last call you had seen some of the admitted carriers start to package in cat risk with the liability risk. Is that something you're seeing pick up at all, or is that kind of more one-off?
We continuously see our least responsible competition would be admitted markets that would come in and compete in the E&S space. Most of that we call it irresponsible because they're competing on price, but their coverages are much broader than the coverages that we sell typically to those insured. By definition, the expectation is they're going to have much higher loss costs than we would have at the same price. We continue to see that. Obviously, we don't see that as much in a hard market because those guys retrench because they get burned. Right now, we still see them.
Gotcha. Okay. Thank you.
Just as a reminder, it is star one if you'd like to ask a question. Our next question will come from Mark Dwelle.
Yeah, good morning. Just one follow-up question related to the medical liability write-off. I was curious why that was in realized capital gains. I've seen that recorded before through operating, and I know there was some feature of this that moved it up to that part of the P&L.
Yeah, Mark, it's Todd Bryant. I think what you'll find is a fair amount of diversity in practice. Our view is based on the relatively small amount relative to our balance sheet income statement that's there, and that's why we did spike it out in some of the disclosures.
Okay, thanks. That's really my only question. Most of my other questions were covered elsewhere. Thanks.
Great. Thanks, Mark.
Our next question will come from Ken Billingsley.
Hi, good morning. Mark asked one of my questions. The other one is, on the investment yield. It's dropped over the last few quarters, and I'm calculating this taking the investment income over and
investment. It dropped another 17 basis points this quarter. Could you just talk about maybe from an investing strategy, if we should expect that this is the new norm or we're going to see another 10 or 15 basis point bleed through the end of this year, just kind of what expectations we should build in.
It's Todd Bryant. It did drop. Basically, as bonds have rolled off with a little higher yields and reinvested at the current market yield, that has had that downward impact and pressure on the overall yield. We feel pretty good in the purchase yield, and the average for the quarter is about 2.8%. To extent, I guess, it's a little bit difficult to predict in the future. We are going to have, again, board turnover in the second half, but we're in a pretty stagnant, low interest rate environment that's going to have that effect until the foreseeable future when we see some uptick. Nothing's really changed too much, and we've been sticking pretty close to about a five-year duration for now several quarters, couple of years anyway.
no changes.
One thing I should've said too, last half of last year and early this year, we did move into a little bit of higher flight to quality, flight to safety in Treasuries, and then more recently, asset-backed MBS.
Okay. there was a change in some of the asset purchases in the last half of 2015?
Yeah. then into the first half of 2016.
Okay. Thank you very much.
You're welcome.
Our next question will come from Meyer Shields.
Hi. Good morning. Thanks a lot for the time. Congrats on the quarter. I had a question about the commercial auto. You made some comments, I think, in the prepared remarks about sort of competitive behavior. I was wondering if that's just really a continuation of, I don't know, the last 12 to 36 months, or you saw sort of some degree of a change in competitive behavior in the most recent quarter as compared to prior quarters.
Meyer, this is Craig. We see a continuation of what we've been seeing over the last 24 to 36 months, I think. It seems like the market hasn't found the right price yet. You're still getting higher rates in general. As I mentioned before, we haven't quite seen the same poor underwriting results that the rest of the industry has in that space. We certainly are enjoying the opportunity to be able to look at business we couldn't look at before because it was underpriced, we felt, and obviously get some price where we can afford it.
Got you. I guess this is sort of the obvious, but in some respects, your sort of win-to-loss ratio, whether it's binding to quote, it's at a higher level than it was in prior years, but hasn't really moved that much further up in the second quarter than it was in more recent quarters. Is that-
Yeah, I wouldn't necessarily say-
staying the same?
I wouldn't necessarily say we're binding at a higher rate, but we certainly are seeing more submissions. It might be slightly higher, but it's not enough to talk much about. It's really an increase in submissions.
Okay. Thanks.
I can tell you okay.
No, go ahead. I'll take any words of wisdom you're willing to offer.
I was going to say, producers are looking for appointments everywhere for new markets that are interested in entertaining commercial auto because it's that tight.
Great. No, that's good news. Thank you.
Our next question will come from Ian Gutterman.
Hi. Thank you. First I just wanted to clarify, I got a little confused there on the medical. Forgetting the goodwill, just the underlying results, are they in the casualty segment, the premium combined ratio and so forth?
This is Craig. Ian, yes, they are. That's an E&S casualty product, but it does fall through the casualty results, yeah.
Okay.
It's a very small portion of our overall casualty results, just so you know. I mean, $10 million is a pretty small role.
Fair. I just want to make sure. Any underlying deterioration is basically already reflected, is what I was trying to get at.
Correct.
It's not something we have to worry about incrementally.
As far as we know.
Okay. Got it. Okay, then I just had a couple other things on casualty in general. Usually, this Q2 seems to be historically your big reserve release quarter, and it's about half of what it was last year in the casualty segment. Anything sort of different from prior years' reserve studies that led to that?
This is Craig. I can answer. Todd might want to jump in here, I know our processes have remained the same for as long as I've been here, over a decade, I know it's the same as what it's been prior. I can't tell you that there's anything that's changed, certainly in our underlying process, We haven't seen any significant underlying trends that would be driving it. I can't explain it, but it is down a little bit from last year, although last year was a little higher than normal, I think.
Okay. Yeah, I didn't mean to suggest process change, anything as far as recent accident years versus older accident years or maybe certain lines of business that have been showing more releases that didn't this year, any kind of color along those lines?
Yeah. This is John. Last year was more of an outlier, though. The second quarter-
Okay
Last year was a bit more of an outlier than. This was not really that different than other second quarters, except for last year.
Okay, got it. The underlying accident year margin improved this quarter and last quarter nicely. Does the fact that casualty rates are starting to flatten out make it harder to continue to improve that? Is there still because they're sort of written from the last year baked and yet to earn that maybe you still have a little bit to go?
I'm sorry, you're asking about our underlying loss ratio in casualty and-
Right. Excellent development.
All I can say about our. The challenge with that is our mix is constantly changing within casualty. Obviously, we're growing things that we think the margins are still good, and we're shrinking the things where the margins are getting tighter. It's very hard to project because almost everything involves a underlying mix change. When you look at the combined ratio, or the underlying combined ratio, even though overall price change might be flat, what you're seeing is us growing some of the products where we're still able to get rate and still find accounts that are attractive, and we're shrinking areas where we're having to give up rate, and also where we find less attractive from a margin standpoint. That's how, I'd say more than anything, we've been able to stabilize the margin of the underlying combined ratio for all of our businesses in general.
No, that makes sense. Thank you. Maybe just one last topic on your paid losses the past couple of quarters have been up double-digit, which is kind of unusual for you guys and is meaningfully faster than the premium growth. Anything one-time in there or?
It's Todd Bryant. I think we're pretty, at least if you look at the first or the second quarter compared to the second quarter last year, it's pretty close. It might be up about $3 million this year versus last year, but I don't think you'd read into a $3 million movement as anything significant. The top line is large as well, albeit these would be typically paying claims from prior years. The only thing I would add is that from our, on the casualty and the surety side, which are growing, the surety side is obviously a little shorter-tail, you're going to get, if you write more of it, if you look in aggregate, you're going to have more paid losses earlier. Also on the casualty side, the products that we've actually been growing are relatively middle-to-shorter-tail casualty products.
Transportation, we would view as a shorter tail product. Package business that we've been growing is a shorter tail product. The umbrella product
That makes sense.
Yeah. Okay?
Okay. I might have, again, I tried to back into the numbers, I might have calculators are wrong as well, I can follow up with Aaron maybe on that. Okay. Thank you guys.
Appreciate it.
If there are no further questions, I will now turn the conference back to Mr. Jonathan Michael.
Thank you very much. Another good quarter, mid 80s combined. We'll take that all day long. Casualty and surety showed strong growth during the quarter. Property continues to be a difficult marketplace, but our underwriters remain disciplined, and they will remain disciplined and be very selective for that business. Thanks again for joining us, and we'll talk to you again next quarter.
Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 1-888-203-1112 with an ID of 7360428. This concludes our conference for today. Thank you for your participation and have a nice day. All parties may now disconnect.
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